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Over-ambitious markets

Of course, markets buy the direction of travel rather than the underlying assets and their spot valuations. That has been confirmed by the 18% gain of the Stoxx600NR since 23 March, reflecting the fact that COVID-19 had peaked here and there as measured by the death-count derivatives. The same index is now “only” c. 20% down on pre-COVID (early March) levels. That sounds pretty optimistic.

Europe will have stalled for a good two months of lockdown (say working at 60% or so of its nominal GDP over that period), is now contemplating stretched and inconsistent COVID-exit calendars, has fully destroyed some essential industries (Tourism, Transport, Media), is facing vast incremental debts and has shown weak political knees. Still, this need not be an issue for the bulls.

This is odd as we still hold the view that the discovery process about the costs and long-term implications of this pandemic is still work in progress. Buying at 22x 2020 earnings down 40% on the previous year and still falling is an extraordinary vote of confidence that presumably relies on continued cheap funding expectations.

While, in China, the Communist Party has not lost the plot and submitted its population to its iron rule, the bulk of the western world has effectively been driven by doctors/ health officials and their own understanding of how not to swamp short hospital capacities. Any pandemic would face scarce health capacities so that the question will inevitably be raised whether it was right for politicians to have given so much space to health experts with no clue about the economic disaster that a lockdown implies. Leave alone the health costs attached to future lost wealth.

The same politicians will now pick up a phenomenal and very real bill with zero political gains and a total loss of legitimacy when time comes to apportion the costs: today and to whom? Tomorrow and to whom? For democratically-elected governments, the conclusion may well be that elections are overdue. That is not the sort of visibility that markets prosper on. Beyond the issue of short-term legitimacy, there is the risk of a reset in a number of industries as the COVID crisis has made it painfully clear that smaller businesses and lowly-paid jobs are essential cogs of society, not to mention the role of strong(er) governments. It is unlikely that the money that will go into more health and security will not be at the expense of “growth” ambitions.

That money is likely to be derived from politically-acceptable taxes, i.e. the corporate and energy varieties while the post-COVID corporate governance will pay more attention to human resources/job conditions and environmental matters. All of that will not be supportive of earnings growth.

As a reminder, listed Europe was on the verge of recovering in 2019 the peak earnings of 2007. It failed, as world GDP growth was not up to expectations. The current reset in progress may well bring earnings well below their 2009 trough. The idea that 2007 earnings may not be recovered by… 2032 should cool down current optimism. And that does not allow for a fully-fledged crisis such as the break-up of the Eurozone.

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Founded in 2007, AlphaValue is the world’s leading provider of Independent European Equity and Credit Research. We provide comprehensive, unconflicted research-only (no execution, no corporate finance) coverage of c. 480 European mid and large cap stocks. We have an average of 46% of negative recommendations at any one time. Learn more at www.alphavalue.com